London, United Kingdom. Prime Minister Keir Starmer appoints Gordon Brown as Special Envoy on Global Finance and Cooperation at 10 Downing Street. Picture by Lauren Hurley / No 10 Downing Street
Political pressure on Prime Minister Sir Keir Starmer is intensifying after Labour’s disastrous local election performance triggered fresh fears about leadership instability, rising borrowing costs and renewed stress across UK financial markets.
Analysts at Natixis warned that investors are increasingly worried about the possibility of a prolonged Labour leadership battle and the prospect of a more left-leaning government emerging from any contest.
“Investor fears over Sir Keir Starmer’s future as Labour leader drove up UK borrowing costs and sent the pound lower,” Natixis said in a new research note.
The bank noted that UK 30-year gilt yields, the area of the market most sensitive to fiscal concerns, have risen sharply since the election fallout intensified, while Sterling has weakened against the euro.
Natixis said immediate risks for markets include “lingering summer-long speculation about Starmer’s future” and the danger of a “protracted contest” should a formal leadership challenge eventually emerge.
While more than 80 Labour MPs are reportedly unhappy with Starmer’s leadership, Natixis highlighted that Labour Party rules make removing a sitting Prime Minister difficult.
“A formal leadership contest is currently not underway, hampered by Labour’s strict rules,” the bank said.
The report explained that challengers would need backing from 81 Labour MPs before any contest could formally begin, creating a significant obstacle despite widespread unrest within the party.
Markets Fear Shift to the Left
Natixis argued that investors are becoming increasingly nervous about who could replace Starmer if pressure continues to build.
The bank specifically highlighted concerns surrounding potential successors such as Andy Burnham or Angela Rayner, who markets perceive as more willing to loosen fiscal policy and increase government borrowing.
“Increased public borrowing costs reflect investor concerns over potential left-leaning Labour successors,” Natixis wrote.
Those concerns come at a difficult moment for Britain’s finances.
UK borrowing costs have already surged following the Iran conflict and the renewed spike in global energy prices, while markets remain sensitive to any signs of fiscal loosening after the 2022 gilt crisis during Liz Truss’s premiership.
Rabobank also warned this week that the gilt market could remain vulnerable if political instability deepens.
“It is certainly not good for the UK Chancellor or the tax paying public to hear that borrowing costs reached multi-decade highs this week,” Rabobank said.
The bank added that speculation surrounding Labour’s future direction risks unnerving investors further, particularly if markets begin pricing in higher spending commitments and weaker fiscal discipline.
Pound Sterling Faces Political Risk Premium
Despite recent resilience in Sterling, several banks now believe the Pound could become increasingly vulnerable if political uncertainty drags on through the summer.
Rabobank said Sterling had so far been supported by rising Bank of England rate expectations, but warned political instability could eventually outweigh that support.
Pantheon Macroeconomics struck a similar tone, arguing markets are now attaching a growing “fiscal risk premium” to UK assets.
“The market reaction to the likely demise of Sir Keir Starmer looks fair,” Pantheon said, adding that replacing the Prime Minister could ultimately lift gilt yields by around 45 basis points.
Pantheon economics also warned that “his defenestration seems to be a matter of when rather than if.”
